Effect of a contractual liability cap on set-off and contractual interest

Topalsson Gmbh v Rolls-Royce Motor Cars Limited [2024] EWCA Civ 1330

The question

Under a contract’s liability cap, should the cap be applied separately to each party’s liability before any set-off or after calculating the net financial position between the parties?

Where there is a contract term stating that interest is the sole and substantial remedy for late payment, should interest for late payment be caught by a financial cap in a limitation of liability clause?

The key takeaways

A contractual cap on liability was interpreted to apply to each party’s liability separately, before any set-off of sums due to each other. The interest on late payments fell outside of the liability cap where the parties had expressly agreed that interest was a “substantial” and “sole remedy” for late payment.

The background

Rolls-Royce contracted with software developer Topalsson to develop a new digital visualisation tool allowing prospective customers to see photo-realistic renderings of Rolls-Royce cars with different custom configurations, before purchasing.

After various delays and disputes, Rolls-Royce terminated the agreement. Topalsson brought a claim against Rolls-Royce in the High Court. Rolls-Royce defended the claim and counterclaimed for its losses arising out of the termination.

The High Court found that Rolls-Royce had validly terminated the agreement and was due termination damages in the amount of circa €7.9 million. This figure was reduced by the amount owed by Rolls-Royce to Topalsson on termination (around €800,000). The judge then applied the agreement’s €5 million liability cap, and awarded Rolls-Royce €5 million in damages, plus contractual interest calculated by reference to the dates when the sums had fallen due.

The agreement included a right of set-off and the wording of the liability cap (clause 20) in the agreement was as follows:

"…the total liability of either Party to the other under this Agreement shall be limited in aggregate for all claims no matter how arising to the amount of €5m (five million euros)."

The decision

There were two broad issues for the Court of Appeal (CA) to consider. These were: (i) the interplay between the contractual liability cap and set-off; and (ii) the interplay between the liability cap and interest.

Issue 1: Liability cap and set-off

Topalsson’s case was that the liability cap should be applied separately to both parties’ liabilities to each other, before setting off the sums against each other. In this case, Topalsson’s liability to Rolls-Royce would be capped to €5 million and Rolls-Royce’s liability to Topalsson would be €800,000, leaving an overall sum due from Topalsson to Rolls-Royce following set-off of €4.2 million.

The CA agreed with Topalsson, finding that the judge in the first instance had been wrong to set-off the financial position between the two parties before applying the liability cap. It found that both parties’ liabilities should be capped separately, and then the set-off applied, reducing the amount due from Topalsson to Rolls-Royce to €4.2 million.

The court focused on the wording in the agreement’s liability clause: “the total liability of either party to the other”, which suggested a totting up, not a netting off. If there had been an intention to apply the cap only after the net financial position between the two parties had been calculated, the clause should have stated that expressly.

The court also commented that the totting up approach was the only interpretation which made “commercial common” sense. If the claim for set-off was taken into account before the cap was applied, the result could be manipulated, so that the party with a right to set-off could avoid the consequences of the cap altogether. By way of example, on Rolls-Royce’s construction, they could withhold the entirety of the contract sum (€9million) by way of set-off, and then also claim damages, to the tune of the cap of €5 million.

Issue 2: Liability cap and interest

Topalsson argued (in an amendment to its pleadings) that as a matter of construction, Rolls-Royce’s claim for contractual interest for late payment by Topalsson fell within the cap in clause 20.

The court did not allow the amendment, but obiter did consider the point and suggested that interest on late payment fell outside the cap in clause 20.

The cap could not be considered in isolation. It needed to be looked at in the context of clauses 14.11 and 14.12:

"      14.11 Each Party may charge simple interest at the rate of 4% per annum above the Bank of England base rate from time to time compounded at monthly intervals from the due date for such payment until the actual date of payment No interest shall be payable under the circumstances of late payment resulting from invoices that are not properly raised or submitted by the Supplier.

     14.12 Each Party agrees that any interest that is payable under Clause [14.11][2] is a substantial remedy for late payment of any sum payable under this Agreement for the purposes of section 8(2) of the Late Payment of Commercial Debts (Interest) Act 1998 and shall be the sole remedy available to the Party entitled to interest for late payment whether in contract tort or restitution or otherwise.”

These clauses made it plain that the parties were agreed that interest payable under clause 14.11 was “a substantial remedy for late payment” and that it was “the sole remedy” available. It would be contrary to the express agreement in those two clauses if interest on late payment was said to be within the cap at clause 20. It would mean that the innocent party, Rolls-Royce, was denied the “sole and substantial remedy” for late payment that the parties had expressly agreed. The interest was an incentive for Topalsson to pay on time. Making interest subject to the cap (and therefore limiting interest payments) would remove this incentive and would, therefore, not make commercial sense.

Why is this important?

The case highlights the importance of considering the wider commercial context surrounding parties’ potential liabilities on termination or breach when drafting liability caps, and the impact any set-off is likely to have on that cap, where sums are likely to be due from both parties.

Any practical tips?

When drafting a limitation of liability clause, consider the sums that might be due to each party in the event of termination or breach. Based on the specific scenario, consider whether set-off should occur before or after the liability cap is applied.

Ensure the words used are clear and precise because the courts will look to the language used in the contract to interpret it as well as applying “commercial common sense”.

To avoid any disagreement as to whether interest for late payment falls within a financial cap, expressly include or exclude this from the cap. The court made it clear that a provision that interest for late payment was included within the cap would require clear words, because otherwise it would be an obvious denial of Rolls-Royce’s common law rights.

Winter 2024